Friday, December 18, 2015

Liftoff At Last

The Fed raised rates for the first time in nearly a decade, fulfilling the
forecast of a 2015 rate liftoff in the final policy meeting of the year. The
well telegraphed move initially sent equities higher as market participants
were relieved to finally get the first rate rise under their belt. The
greenback strengthened on the rate move, keeping pressure on already weak
energy prices. Other central banks reacted as countries closely aligned with
the US economy raised rates in tandem while the Bank of Japan created more
monetary policy divergence by adding more stimulus. As the Fed rate hike sank
in, stocks sold off into the weekend and for the week the DJIA ended down 0.8%,
the S&P fell 0.3%, and the Nasdaq lost 0.2%.

After the Fed spent the last year talking about rate liftoff, it finally
happened on Wednesday. A 25 basis point hike took the key rate off of the zero
bound where it has been sitting since December 2008. Chair Yellen said that a
rate rise acknowledges that considerable progress has been made in the economic
recovery. Yellen managed to keep the rate decision collegial, getting a
unanimous vote in support of the hike, and supporting it with a mostly dovish
statement. The Fed specified that the rate hike path will be
"gradual," maintaining its median 'dot chart' forecast for about four
more rate hikes in 2016.

US Treasury markets saw sellers emerge ahead of the FOMC announcement. On
Tuesday the 2-year yield backed up to 1.00% for the first time since 2010 and
the 10-year rate consolidated around 2.30%. By Friday though, a post-FOMC sell
off in equities helped push yields lower and resulted in a flatter US curve.
The benchmark 10-year finished the week some 12 basis points below pre FOMC
levels.

Manufacturing continued to be a sore spot for the US economy. The December
Philadelphia Fed Business Outlook fell to its lowest level in two years. The
Markit Manufacturing PMI reading declined with its new orders component
registers the weakest reading since 2009. November industrial production
steepened its sequential slide and the October was revised lower. On a positive
note, US housing starts in November rebounded from a seven-month low and
permits surged to a five-month high. November marked the eighth straight month
that starts remained above 1 million units, the longest stretch since 2007 and
growth was seen in the single family segments.

Other central banks reacted to the historic Fed liftoff from the zero bound.
The day after the Fed move, the Mexico central bank raised its rate by 25 basis
points to 3.25%. The Banxico said the rate move was aimed at preventing further
peso depreciation and that it would focus on relative monetary policy stance
with the US. The Chile and Colombia central banks also raised rates by a
quarter point each. Meanwhile, the Bank of Japan highlighted the ongoing theme
of monetary policy divergence by unexpectedly announcing a ¥300B boost to its
ETF purchase program on Friday.

Political turmoil in Brazil spilled into the financial markets when Fitch cut
its sovereign rating to junk, matching a downgrade by S&P earlier this
month. The announcement was wrapped around continued soft economic data and a
growing political crisis in which President Rousseff faces impeachment and the
finance minister is said to be on the way out. In neighboring Argentina, new
President Macri lifted long standing currency controls, effectively resulting
in a devaluation of the currency and sending it lower by ~28% against the US
Dollar.

After announcing a tentative deal early in the week, the US Congress moved to
pass a $1.1T omnibus spending bill on Friday. House Republican and Democrat
leaders scraped together enough votes to pass the compromise bill and the
Senate followed suit. One notable feature of the bill is the repeal of the ban
on US crude oil exports, which was traded for authorizing a five year extension
of solar tax credits. Solar energy stocks performed very well on this
development, even as the broader energy sector showed weakness again as crude
oil plumbed new lows.

Oil prices came into the week sitting near a 7-year low around $35/bbl and
continued to drift lower with no relief. News that Congress lift the oil export
ban imposed four decades ago was more than offset by a surprise build to US oil
inventories. WTI finished the week below $35 and is closing in on the December
2008 low of $32.40. Brent is even closer to the previous low of $36.20 hit in
late 2008. Natural gas fared no better, continuing to hit fresh 13-year lows
below $2.00 as the week wore on and unseasonably warm weather continued in the
eastern part of North American.

Cheap fuel costs have failed to spark the economy and the DJ Transportation
Average has remained a bugaboo for many investors. Knight Transportation gapped
lower after cutting its Q4 outlook, weighing on trucking and logistics
competitors. On Friday, FedEx quickly gave back all of the gains it made on its
Q2 earnings report earlier in the week. Shares of UPS and FDX came under
substantial pressure follow a report that Amazon is in talks to lease 20 cargo
jets from Boeing so that it can launch its own air-cargo service to handle more
of its own shipments. By Friday, the DJ Transportation Average fell to a new
2015 low below 7400, further spooking some old-school Dow theorists.

Various US corporations offered up initial FY16 forecasts, and some were not
very well received. MMM shares slid after cutting this year's forecast and
guiding next year towards the low end of consensus expectations. Kennametal
dropped aggressively after management guided FY16 earnings down as much as 60%.
Oracle continued growth in the cloud market failed to impress investors who
sold off shares following its Q2 earnings report.

On Tuesday, embattled drug-maker Valeant announced a deal to distribute some of
its medicines at a discount through Walgreens pharmacies. The very next day
Valeant reset investors' expectations by cutting its 2015 forecast and guiding
FY16 earnings below expectations. Shares surged more than 15% as the company
looked to put to bed weeks of controversy surrounding alleged questionable
business practices.

Deal flow slowed this week but there were a few notable developments. Newell
Rubbermaid agreed to buy Jarden for $60/share in a cash-and-stock deal valued
around $15 billion. For each Jarden share, Newell will pay $21 in cash and
0.862 of a share in Newell. The companies pegged the deal's total value at
$15.4 billion, when including the convertible debt on Jarden's balance sheet.
Avon confirmed a long speculated tie up when private equity firm Cerberus
agreed to acquire an 80% stake in Avon North America, separating it from its
parent company. Cerberus also agreed to take a 16.6% stake in the parent
company. As part of Avon's strategic restructuring management confirmed they
were suspending the quarterly dividend. The regulatory reviews of the Baker
Hughes Halliburton deal continued to push ahead slowly. Both European and US
regulators extended their decision time frames into next year.